Is there an income approach to business valuation that does not rely on a terminal cash flow? I have cash flow projections for a finite time period based on a given interest rate scenario. However the subject company is a mortgage company so the cash flows of the scenarios are path dependent, so when my projections run out I’m reluctant to calculate the the terminal value by setting up a perpetuity paying X. I’m leaning towards a multi-stage model that has a series of annuities leading toward business income stabilizing and eventually leading to a perpetuity, but if there is some way to avoid a terminal cash flow altogether while still using an income approach I would love to hear it.
Sorry for hijacking your thread, but could you (or anyone) tell me whether I can use any sort of DCF for Commercial Bank Valuation? FCFF/FCFE does not work at all. However I seem to get some results using Residual Income method. Thanks.
What do you mean? Where are you getting your CF? What about your free CF models don’t ‘work at all’? What do you mean by you get ‘some results’ using Residual Income? Are you trying to tie it out to something?
H-Model maybe? You will still need some “perpetual” growth rate assumption but you could make it pretty low to be conservative. Just a guess
Re income approach - that would be a valuation based on PE or EV/EBITDA.
You could try building your terminal value off of a multiple based on a more stable non-cash flow characteristic. As a similar example within the cable business you could use an EV / Homes Passed multiple so if you could find a less variable trait within the MBS industry that might work. The obvious flaw is that if the underlying mortgages deteriorate, reducing cash flows, the multiple assigned to that alternative factor will decline to offset the stability of the factor. So to sum it up, I think the concern you’re voicing relates to the volatility of mortage related (path dependent) cash flows. However, since these cash flow actuals will directly impact the value of the firm at any future point in time, there’s really no way to get around the inherent volatility in the vaulation. As kh.asif is finding out this is why financially related businesses are typically valued (with mixed results) by wackos with crazy industry backgrounds. And by the way kh.asif, FCF models do work for financial institutions, it’s your assumptions.
What i have done in the past is: 1) project detailed FCF for five years 2) grow that FCF annually for the next 15-20 years, ie assume FCF grows 5% annually years 6-10, 2% annually years 11-20 etc., whatever makes sense 3) assume terminal value at year 20=$0. This is conservative but if you discount any terminal value back 20 years the value will be minimal. Helps avoid a scenario where much of your NPV comes from the terminal value. This is a bit simplistic, but my 2 cents.